CNB Stepping on the Brake: Further Interest Hikes and Mortgage Restrictions
After several years of intervention against the Czech Crown (CZK) to ensure a rate above CZK 27 / EUR and keeping interest rates at almost zero, the Czech National Bank (CNB) has sharply changed its course in 2018.
The CNB’s new goal is to react to signs of overheating on the domestic market. The boiling economy is best visible for the public on the property market (sharp rise in real estate prices) and on the labor market (acute shortage of workforce, sharp rise in wages).
The CNB is in particular concerned about a real estate bubble, given relatively relaxed lending terms by domestic banks in combination with approx. 45% property price inflation since 2015 (in Prague and Brno up to 80%). To let off some steam, the CNB decided a threefold strategy.
First, the gradual increase of the CNB’s interest rates since November 2017 has gained momentum in recent months, resulting in the current 2W repo rate of 1.50%. Further 2 – 3 hikes in the coming months are likely to come to get closer to the CNB’s target rate of 2.50% – 3.00%. Commercial banks have partially reflected the increased rates in their current mortgage rates; however, strong competition on the mortgage market prevented the banks to mirror the interest rate increase in full.
Second, in anticipation of a potential burst of the property bubble and its impact on the banking sector, the CNB increased its countercyclical capital buffer rate for the banks to 1.50%(up by 100 bps since 1Q 2018).
Third, the CNB has imposed unprecedented restrictions on new mortgage lending. As of 1 October 2018, the CNB has included income requirements in its mortgage lending recommendations. An applicants’ debt should not exceed nine times their net annual income. At the same time, applicants should spend no more than 45% of their net monthly income on debt service. Special cases not meeting these criteria shall not exceed 5% of all new mortgages of the particular bank.
Further, previously imposed recommendations regarding a loan-to-value ratio (LTV) are to apply as well. This means that loans with an LTV of 80–90 % may account for not more than 15% of all mortgage loans provided by banks. Loans with an LTV exceeding 90% shall not be granted at all.
It should be noted though that the above recommendations are not legally binding on the banks. Nevertheless, the CNB has been trying for some time to change this and to get statutory power to make these rules mandatory. In any case, banks are expected across-the-board to comply with the CNB’s mortgage terms.
According to estimates by market professionals, the new rules will prevent a majority of young families and middle-class individuals from buying newly-built residential property in large Czech cities. Especially new homes in Prague and Brno may be soon out of reach for 40% of potential buyers. The current trend will inevitably force more people to look for rental opportunities, thus driving demands for higher rent by landlords.
Anyway, it seems that the property markets in Prague and Brno have stabilized somehow in the past few months as price growth has slowed down significantly. Buyers seem to be less willing or able to pay the requested amounts and the envisaged economic slowdown may also be taken into account. Last but not least, the LTV regulation by the CNB has taken its toll too. It remains to be seen, how much further the CNB’s new rules will cool down the property market.